Sector Leadership Says What It Says

Friday Primer

Given the market expected the Fed to taper again this week, Friday brings
the most important economic event of the week; the monthly employment report.
The Bloomberg consensus forecast calls for a gain of 215,000 jobs, with a forecast
range of 190,000 to 279,000.

Markets Set Asset Prices

Why should we be concerned if the market is waving "we are losing confidence" flags?
The market determines the value of our investments. You may not agree with
the market, but taking a contrarian stance, especially over longer periods
of time, can be a painful learning experience.

Confidence vs. Concern

The S&P 500 High Beta ETF (SPHB) is heavily weighted toward economically-sensitive
sectors, such as energy and financial services.

On the other end of the equity spectrum is the S&P 500 Low Volatility
ETF (SPLV), which holds more defensive-oriented stocks, such as McDonalds (MCD),
Walmart (WMT), and Johnson & Johnson (JNJ).

Common Sense Says Tone Has Shifted

The chart below shows the performance of high beta stocks relative to defensive
stocks. In the second half of 2013, the ratio showed strong bullish conviction
about future economic outcomes, earnings, and Fed policy (below point A). Economic
doubt began to creep in above point B, telling us the market's tolerance for
risk has been deteriorating for several weeks.

Yellen The Magnificent

It seems as if elected politicians are doing less and less and the Fed is
doing more and more, which is a theory shared by many money managers. From The
Wall Street Journal:

Hedge-fund manager Paul Singer has a nickname for Federal Reserve Chair
Janet Yellen: "Yellen the Magnificent." But the spin on Johnny Carson's
famous mocking mystic sketch is not a compliment. "The Fed has lost any
semblance, any wispy remnant of humility, introspection, caution and historical
perspective. It is all cameras and applause," he wrote in the letter, sent
last week. "The Fed (along with other central banks) is fully immersed
in fiscal policy, arrogating more and more responsibility for the functioning
of the global economy, picking winners and losers in purchasing financial
assets, directing the allocation of credit and making ever-bolder predictions
ever-further into the unknowable future."In effect, it is achieving total
political power in a political vacuum, without the accountability of being
elected," he added. "If you open a faucet in the winter and only a trickle
comes out, what do you do? Easy! Open it wider. In fact, open ALL the faucets!
Brilliant! Now they are all trickling. But when the pipe blockage comes
unstuck or the ice melts, you will have a flood," he wrote.

Having the Fed do all the heavy lifting is a plan that could backfire sometime
down the road.

Investment Implications - Not Much Has Changed

On April
4, we noted the possible economic significance of the Dow being able
to post a new closing high. Industrial stocks finally cleared the hurdle
Wednesday. How long did the euphoric breakout state last? For now the answer
is "one day". As shown in the chart of the Dow below, Thursday's decline
in industrial stocks moved the breakout into possible fake-out territory.
If the breakout fails, that also provides insight into perceptions about
the strength of the economic recovery.

With a non-farm payrolls report coming Friday morning and given the market's
seemingly-now-never-ending bout of indecisiveness, we have made no changes
this week. If you want to really know what someone thinks about the market,
ask them what they own. We own a fence-sitter's portfolio with a slight bullish
bias, consisting of U.S. stocks (SPY), bonds (TLT), and cash. The SPHB vs.
SPLV ratio discussed here says it remains prudent to have some bonds and cash
to offset increasing risks in the equity markets. In Friday's article, we will
post an updated version of the weekly S&P 500 chart below. It will be interesting
to see if the bullish look and 18 point gain can carry into the weekend. We
will see what Friday brings.

This entry was posted on Thursday, May 1st, 2014 at 4:30 pm and is filed under Stocks
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Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

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